March 14, 2011

Japan Market Should Rebound From Quake's Impact, Says Hennessy

Value investor Neil Hennessy reports that SPARX people and operations in Tokyo are safe and functioning

Neil Hennessy said that following the Japanese earthquake early last Friday, the SEC phoned him to inquire about his asset management firm’s business continuity plan. In an interview on Monday with AdvisorOne, Hennessy reported that not only were the people who help run the Hennessy Select SPARX Japan and Smaller Companies mutual funds all physically safe, it was business as usual in the SPARX Tokyo offices.

In discussing the impact of the devastating earthquake, tsunami and nuclear power plant explosions in Japan, Hennessy said that “when you have a catastrophic event you’re going to have people running for the sidelines,” but that he firmly believes the disaster will not cause any devastation in the financial markets.

“We look at things with common sense and logic,” said Hennessy from his firm’s Novato, Calif. headquarters. “We partner with people in Tokyo who are very good. They’re not going to sell into” the market, where the Nikkei fell 6.2% in Monday trading, “and I support them for that; I back every decision they make.”

Acknowledging that he is an “eternal optimist,” Hennessy (left) noted that a week ago in Japan there was much consternation over the political situation—Prime Minister Naoto Kan stands accused of illegally receiving campaign funds, and there had been calls for him to resign his post. “Now,” said Hennessy, in the wake of the earthquake “the politicians are working together.” Indeed, the ruling Democratic Party of Japan (DPJ), led by Kan, and its main rival, the Liberal Democratic party (LDP), which had dominated post-war Japanese politics until the DPJ won a 2009 election, agreed on Sunday to discuss a temporary tax levy to pay for the disaster cleanup.

The Japanese people, Hennessy reports, are “calm and methodical and they will get through this.”

Hennessy is also optimistic over investing in Japan, which he calls an undervalued market but one that is changing, and for the better. “For the past 20 years no one has wanted to invest in Japan,” Hennessy admitted, citing the country’s spiraling debt, demographic issues and weakening economy, particularly when compared to fast-growing China. Now, he says, “the government wants businesses to succeed,” citing in particular Japan’s sponsorship of tourism and in changing its policies easing the way for increased tourism from China.

Hennessy argues as well that just as the Japanese “made a lot of money selling life-enhancing products to Americans,” the country now has the “same opportunity” to sell  similar products to the rapidly growing Chinese middle class. “You can look at the debt” of Japan, he says, but points out that it’s internally financed. Japan remains the “gateway to Asia” with the products and the technology to grow.

Hennessy, who’s a true believer in using the price-to-sales ratio in valuing a potential investment (see a recent AdvisorOne interview exploring why he expects the Dow to rise 8% to 12% this year) says that when he looks purely at the numbers—“in this business, when you come into the office you have to put your

emotions into the closet”—in Japan “you can buy a dollar of revenue for 50 cents.” In the BRIC countries, by contrast, “you’ll pay $1.85 for $1.00 in revenue.” That’s why he’s surprised that there’s only $2.6 billion invested in Japan-only mutual funds, compared to total Asia ex-Japan mutual fund assets of about $26 billion. Japanese companies are, like American ones, “cash flush, and they’re looking to partner with other countries.”

 

The Ramifications of the Disaster for U.S. Investors

So if the Japanese will recover and its companies will still be undervalued, what about the impact of the disaster on American consumers and investors?

Oil, for instance, declined on consensus expectations that there will be less demand from Japan as it focuses on its recovery. But Hennessy is skeptical of that reasoning. “The bottom line of why oil has been going up has been the futures market—speculators.” Hennessy argues that “there’s no supply issue” and as long as that’s the case, “there’s no reason for oil to be over $100 barrell.” Moreover, once oil goes over $80 a barrel, “it’s not in their favor in the Mideast,” since alternative sources of energy become much more economical.

However, when it comes to non-oil energy sources, he argues that “the reality of the world, be it wind, nuclear or other alternatives, you still need permits, and no one,” especially in the United States, “wants it in their backyard.”

Turning again to Japan and the nuclear plant and oil issue, Hennessy says that while Japan is “energy dependent, they’ve figured out” how to run their economy “without much oil.” He expects that the country will shut down its nuclear plants to ensure they’re structurally sound, but then bring them back online.

One positive development to come out of the disaster, Hennessy believes, is that the international community, which has already marshaled its efforts to help Japan, will see the “ingenuity of the Japanese people come out.”

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